Cartel Behavior

Despite the huge backlog of inventory of both bank-owned properties and shadow inventory, the banks are in no hurry to liquidate. It is classic cartel behavior.

When OPEC first formed, a group of oil producers had an idea: if they all agreed to restrict production, it will drive up prices and make them all rich. When they first put their plan into motion in the 1970s, it worked. The member countries curbed production, and prices went up. Once prices were high, each member country had incentive to cheat to obtain more income at the higher price, so the cartel weakened, and many argue it has little or no power today.

Similarly, the heads of all the major lenders today are like minded: they all agree that processing foreclosures into a weak job market will lower prices and reduce the value of their holdings. They all came to this conclusion in 2008, and during 2008 and 2009, they stopped processing foreclosures and restricted the inventory on the market to keep prices high, and it worked.

As the economy pulls out of this recession, each of the members of the banking cartel will change their opinions about the economy and the market. Some will evaluate their procedures and determine changes are in order, and some will evaluate the amount of inventory they must chew through and determine they better get going or they will own real estate for the next 20 years.

The 2:00 problem

Years ago I attended a seminar where the speaker was Kevin Haggerty, 7-year head of trading at Fidelity Capital Markets. He described what is known as the 2:00 problem.

When mutual fund managers want to buy or sell stock, they call the trading desk and place an order. Since these orders are often very large, it may take quite some time to get their orders filled. Let's say the trader was asked to fill a 100,000 share order, and at 2:00 he has only accumulated 60,000 shares. He informs the head of trading who calls the fund manager. The fund manager has to make a choice: (1) either wait and get the order filled tomorrow, or (2) have the trader fill the order regardless of what it does to the stock price. Filling a large order at the market can cause a major change in price.

The banks have a 2:00 problem… almost. It is only 12:00 in their world. They have only filled a tiny fraction of their original, market-clearing order, and they feel no urgency to fill the order through lowering price… yet.

Two o'clock is coming. When the economy starts to recover, banks will get pressure from regulators and stockholders to clean up the mess on their books. Lenders are not synchronized, and each one will hit 2:00 at a different time. The volume necessary to clear the garbage is simply not going to happen at current price levels. The price-income mismatch makes that impossible. At some point, the pressure to liquidate will force them to impact the market.

Ever since the housing collapse began, market seers have warned of a coming wave of foreclosures that would make the already heightened activity look like a trickle.

The dam would break when moratoriums ended, teaser rates expired, modifications failed and banks finally trained the army of specialists needed to process the volume.

But the flood hasn't happened. The simple reason is that servicers are not initiating or processing foreclosures at the pace they could be.

It really is that simple. I see uninformed shills write that there is no shadow inventory and other nonsense that realtors tell their customers to dupe them into a false sense of security. The fact is that shadow inventory does exist. It is very large, and eventually banks are going to have to liquidate this inventory. This liquidation will be the collapse of a cartel and may not be the orderly flow they are hoping for.

By postponing the date at which they lock in losses, banks and other investors positioned themselves to benefit from the slow mending of the real estate market. But now industry executives are questioning whether delaying foreclosures — a strategy contrary to the industry adage that "the first loss is the best loss" — is about to backfire. With home prices expected to fall as much as 10% further, the refusal to foreclose quickly on and sell distressed homes at inventory-clearing prices may be contributing to the stall of the overall market seen in July sales data. It also may increase the likelihood of more strategic defaults.

I have pointed out on many occasions that lender policy is encouraging strategic defaults.

It is becoming harder to blame legal or logistical bottlenecks, foreclosure analysts said.

"All the excuses have been used up. This is blatant," said Sean O'Toole, CEO of ForeclosureRadar.com, a Discovery Bay, Calif., company that has been documenting the slowdown in Western markets.

Banks have filed fewer notices of default so far this year in California, the nation's biggest real estate market, than they did 2009 or 2008, according to data gathered by the company. Foreclosure default notices are now at their lowest level since the second quarter of 2007, when the percentage of seriously delinquent loans in the state was one-sixth what it is now.

Let that sink in: banks have six times as many delinquent borrowers, but they are foreclosing on less of them. What do they expect to do with all these squatters?

New data from LPS Applied Analytics in Jacksonville, Fla., suggests that the backlog is no longer worsening nationally — but foreclosures are not at the levels needed to clear existing inventory.

The simple explanation is that banks are averse to realizing losses on foreclosures, experts said.

"We can't have 11% of Californians delinquent and so few foreclosures if regulators are actually forcing banks to clean assets off their books," O'Toole said.

Officially, of course, this problem shouldn't exist. Accounting rules mandate that banks set aside reserves covering the full amount of their anticipated losses on nonperforming loans, so sales should do no additional harm to balance sheets.

Within the last two quarters, many companies have even begun taking reserve releases based on more bullish assumptions about the value of distressed properties.

That is mark-to-fantasy accounting. The banks are using bullish assumptions that can't possibly come to pass given the huge inventory that must be liquidated.

Now there is widespread reluctance to test those valuations, an indication that banks either fear they have insufficient or are gambling for a broad housing recovery that experts increasingly say is not coming.

Banks did not choose the strategy on their own.

With the exception of a spike in foreclosure activity that peaked in early-to-mid 2009, after various industry and government moratoriums ended and the Treasury Department released guidelines for the Home Affordable Modification Program, no stage of the process has returned to pre-September 2008 levels. That is when the Treasury unveiled the Troubled Asset Relief Program and promised to help financial institutions avoid liquidating assets at panic-driven prices. The Financial Accounting Standards Board and other authorities followed suit with fair-value dispensations.

These changes made it easier to avoid fire-sale marks — and less attractive to foreclose on bad assets and unload them at market clearing prices. In California, ForeclosureRadar data shows, the volume of foreclosure filings has never returned to the levels they had reached before government intervention gave servicers breathing room.

Some servicing executives acknowledged that stalling on foreclosures will cause worse pain in the future — and that the reckoning may be almost here.

"The industry as a whole got into a panic mode and was worried about all these loans going into foreclosure and driving prices down, so they got all these programs, started Hamp and internal mods and short sales," said John Marecki, vice president of East Coast foreclosure operations for Prommis Solutions, an Atlanta company that provides foreclosure processing services. Until recently, he was senior vice president of default administration at Flagstar Bank in Troy, Mich. "Now they're looking at this, how they held off and they're getting to the point where maybe they made a mistake in that realm."

Did you catch that? That is the beginning of the end for the lending cartel. Once they lose their like-minded action, once some of the cartel members begin to liquidate, prices will fall, and the cartel will crumble.

Moreover, Fannie Mae and Freddie Mac have increased foreclosures in the past two months on borrowers that failed to get permanent loan modifications from the government, according to data from LPS. If the government-sponsored enterprises' share of foreclosures is increasing, that implies foreclosure activity by other market participants is even less robust than the aggregate.

"The math doesn't bode well for what is ultimately going to occur on the real estate market," said Herb Blecher, a vice president at LPS. "You start asking yourself the question when you look at these numbers whether we are fixing the problem or delaying the inevitable."

I am amazed that anyone involved really thought the bailouts and false hopes would actually solve this problem. There was never any chance. Those programs were obviously delaying the inevitable.

Blecher said the increase in foreclosure starts by the GSEs "is nowhere near" what is needed to clear through the shadow inventory of 4.5 million loans that were 90 days delinquent or in foreclosure as of July 31.

LPS nationwide data on foreclosure starts reflects the holdup: Though the GSEs have gotten faster since the first quarter, portfolio and private investors have actually slowed.

"What we're seeing is things are starting to move through the system but the inflows and outflows are not clearing the inventory yet," he said.

I find it surprising that the government is actually leading the collapse of the cartel. Don't be surprised if the GSEs stop their foreclosure activity under pressure from banking interests that would rather see us become Japan than see themselves forced out of business.

Delayed foreclosures might be good news for delinquent borrowers, but it comes at a high price.

Stagnant foreclosures likely contributed to the abysmal July home sales, since banks are putting fewer homes for sale at market-clearing prices.

Moreover, Freddie says a good 14% of homes that are seriously delinquent are vacant. In such circumstances, eventual recovery values rapidly deteriorate.

Defaulted borrowers were spending an average of 469 days in their home after ceasing to make payments as of July 31, so the financial attraction of strategic defaults increases.

One possible way banks are dealing with that last threat is through what O'Toole calls "foreclosure roulette," in which banks maintain a large pool of borrowers in foreclosure but foreclose on a small number at random.

O'Toole said the resulting confusion would make it harder for borrowers to evaluate the costs and benefits of defaulting and fan fears that foreclosure was imminent.

For as cold as Sean's idea is, it would probably be effective. Random violence is an effective method of generating terror, and what Sean is suggesting is that lenders become terrorists.

Is that what this has devolved into? Are lenders going to resort to terrorist tactics to compel people to pay for lender's stupid lending mistakes? Are we going to allow lenders to do this? When will the government act for us rather than for the lenders?

The idea that lenders could and would do this makes me want to see them die.

The cartel in action

I am featuring a property today that demonstrates the macro-economic concept I discussed in the post. I originally featured this property back in January in Foreclosures Ravage Irvine’s High End.

This property was built with a $4,300,000 loan from Fullerton Community Bank. Loans like this inflated high-end pricing, and their absence has created a huge vacuum that no lender is ever going to fill. Evidence of the precarious nature of high end properties is evident with $2,650,000 losses in Irvine real estate.

Back in January, they were asking $4,500,000. A wishing price. They are now down to $4,195,000, and no buyers are to be found. It is 12:00 in their world. They are still in denial. Despite the obvious evidence of long-term weakness in this market, they are holding out for that one buyer who could bail them out. Unfortunately, so are hundreds of other desperate sellers at these price points.

Eventually, it will be 2:00, and they will have to make a decision about liquidation. Either they will mark it way down to sell it, or this may be REO until 2018 when their asking price is market. Which do you think they will chose?

According to the listing agent, this listing is a bank owned (foreclosed) property.

Bank Owned Estate presented in distinctive Andalusian Style, this custom designed and built home artfully balances grand scale spaces with an extraordinary attention to detail. Numerous viewing decks and a courtyard entry pay tribute to Old World traditions, while graceful archways, hand turned balustrads underscore the architectural theme. With 2 of the 5 bedroom suites & an office on main level, this 9600sqft home offers optimal flexibility.Oasis like landscaping with various waterfalls enhance the villa appeal of this magnificent residence. Subterranean soaking pool, sauna, home theatre/game room/ bar and a temperature controled wine cellar with custom racking and table seatings of 8 or more. Optional Elavator.

50 thoughts on “The Upcoming Collapse of the Banking Cartel”

I’m confused. I don’t see Sean’s idea as cold. If people are trying to work the system by strategically defaulting and by doing so, getting a piece of the “squatting” pie, why wouldn’t banks discourage this by strategically foreclosing? If prices go any lower, they are looking at having a mass of people strategically default. The only way to minimize the attractiveness is to make foreclosure potentially imminent.

I just watched an old neighbor put their home up for sale and their tenant move out the following month, fearing that the house would sell and they’d have to find another rental under less than optimal conditions. The house was overpriced, so the likelihood of that was small, but the fear drove them out early. Same concept.

No argument with most of the above, but I also seem to remember that there would be a decrease in the number of defaults based on the decrease in the number of ARMs recasting for the space of about a year of so. I am looking at one of the charts that graphically demonstrate when and how many ARMs recast/reset and the nadir of the number of recasting ARMs was September of 2009. Since it now takes more than one year on average for an NOD to be filed after default, it is to be expected that the foreclosure filings would subsequently decrease for awhile. My guess is that they will start increasing again in about 3 months.

Maybe as far as buying goes. I’m not so sure as far as rents go. Seems to me that there are going to be quite a few Las Vegas landbarons fighting over the scraps for renters. I don’t see how these conditions are favorable from a landlord’s perspective.

I’m with ‘Stock Investor’ on this one. I think we’re looking at secular economic downturn, which will put negative pressure on all asset classes and most assuredly discretionary spending as an aggregate. Rents too will likely fall.
I would like to see IR succeed in his venture. He certainly deserves it IMO for his efforts the last several years in helping to educate the masses about avoiding mistakes in RE.

Man I just think it’s really risky right now. I know sentiment is very bearish, and that’s a ‘classic sign of a bottom’ but sometimes it’s darkest just before the lights go out completely.
There’s trememdous structural problems in our economy and a massive debt burden and trade deficit on top.

Don’t be too sure of that, IR. Remember something about Las Vegas: it is a city built on the entertainment industry only, and wildly overbuilt at that. It was a good bet only when Americans had, or felt they had, a lot of money to throw around, and those days might be gone forever.

It just could be that our economy, which for so long has been founded on financialization and on “industries” such as gambling (or “gaming”, as it’s termed to make it sound respectable), entertainment, and other “fluff” businesses totally dependent upon consumers with unlimited credit, are done for. Las Vegas has no other type of industry.

I believe that our economy is going through an epochal shift, from “tertiary” and secondary type industries back to things that are productive of goods and necessary services, that we need to live, and I also believe we are shifting to a new energy regime, one in which energy will be a lot more expensive.

California will survive, and most likely thrive, because it has many productive industries, such as high tech, which will become more, not less, important as we search for ways to make the most of our resources. It may or may not survive in exactly it’s current form, but it has so much going for it in the way of scenery, climate, and ocean access that it can accommodate many different industries. Las Vegas cannot.

There was widespread despair 10-15 years ago in Detroit – did that signal a market bottom?

Alot of the high roller business in Vegas was driven by an influx of high rollers from Asia who now have many opportunities to spend locally, such as in Macau, which is now larger than Las Vegas. And Singapore is now becoming a larger player. In short Vegas looks alot like GM and Chrysler while Macau and Singapore look like Honda and Toyota.

The other thing is that you will see more supply come on line in other states. The reason is simply – US States are cash strapped and gaming is a popular ‘sin tax’. For example, Pennsylvania just allowed its casino’s to offer table games, which was the only advantage Atlantic City had over them. Can’t one see Californa allowing gambling as a way to earn (much needed) revenue?

Even if/when gaming comes back (gaming would IMHO be a discretionary consumer expenditure that will lag, not lead, coming out of any recovery) I don’t think Vegas will return to peak levels, there is just alot more supply out there and it won’t recover historical market share.

Why stop with gambling? All of these “sins” that are against the law, are nothing more than one puritan generation manipulating and controlling another. When manipulation and control don’t work (i.e. prohibition) then they incarcerate.

What happened between the seperation of church and state? Why is gambling illegal? Why is prostitution illegal? Why is consuming cannabis illegal?

Why would killing you be wrong? Or stealing all your possessions? What about telling everyone you were a child molester, whether that was true or not? Everyone deep down is a puritan, especially if they have been wronged.

If a “sin” does not harm another, but is a willful action or consent of one or both adults, why should there be a penalty?

Government is necessary to prevent people from hurting each other. That is why there are laws, to PROTECT us from each other. I do not like the laws that try and protect us from “ourselves” based upon the opinions or belief’s of another.

I was attempting to post in humor…a dark humor for sure, but some corner of me is the blackest cynic. Maybe it’s my way of coping with whatever comes down the pike….because it can’t be worse than I imagined.

IR or anyone else….we are considering selling our Woodbridge condo in the next 6 months. We’ve never sold before. How do you find a realtor willing to take less than 6% commission? I think 6% is standard.

Sue, simply negotiate. If they won’t do the job for less than 6% there are many others that will. When I sold my last house, I told my agent it will be 5% total commision period, take it or leave it. Additionally, I had the exterior painted, fixed all the small things and had it immacuately clean and I priced it to sell. The place sold within 10 days. I basically told my agent I did all the dirty work getting the place ready to sell and priced it right…5% is more than generous in my book.

Could try Redfin.com
We used them as buyers agent (haven’t tried as sellers agent) and it all worked very well. A bit impersonal (all online) but the realtors (it was a team – senior agent to negotiate offers, junior agents to open doors with lockbox keys) did a good job, highly satisfied.

Sorry, I didn’t realize that. Honestly, if I were selling I wouldn’t be too concerned about an extra 1 or 2 percent that I was losing and would go with someone who had experience selling in the Irvine market and in your neighborhood in particular.

I am a renter in Irvine and there are one or two realtors who dominate the sellerss listings in the neighborhood. I’m sure they charge a lot, but their listings get sold quickly and for prices that are equal to or above the comps.

There have been several sellers who are listed as for-sale-by-owner or who have used something like ziprealty and those houses seem not to be able to sell quickly.

Even I negotiated for 5% and that was back in ’07 before the crash. Furthermore, the realtor that I dealt with was reputable in that area (she was selling several multi-million dollar homes). The staging that was done was so good probably not even IR can spot a problem.

I agree with some of the other posters. 6% is the bend-over rate. My Realtor did it for 4% years ago (1% for him and 3% for the buyer). We had the option to make the buyer 2% or 2.5%, but that risked turning off buyer Realtors, so I opted for the full 3%.

Redfin is 1.5% on the sell-side.

I’m not sure what value a local Realtor has over any other. As a seller, the real value is the MLS listing and perhaps the Open House. Clearly you want your house to show well and I suppose some Realtors can be helpful in that regard, but 1-2% is some costly advice! An astute seller working with an average Realtor should probably get the job done.

Of course, you will hear (imo) the scare tactics of how the higher commissioned Realtor will sell the place for more and therefore will “earn” the extra 1-2%. In the end, your pricing and luck (including market conditions changing for better or worse) will probably be the biggest factors for success or failure.

Prior to the deflation of the housing bubble, lenders would have been classified as “must sell” inventory holders. They have changed their behavior and decided not to sell which is why we have such an enormous backlog of houses in both visible and shadow inventory.

The people who must sell for other reasons are often underwater, and their solution is generally to abandon the property, then it becomes a problem for the banks.

Eventually, this must sell inventory will hit the market and push prices lower.

Yeah, but that is currently funding bank reserves and the created currency is not flowing out to other parts of the economy. I mean that the Fed may start buying property, directly, from Joe 6-pack consumer.

I agree, the bank blew it by being greedy.
They should’ve started the dance initially at $4.195M,
$100K off what they took it back for.
Instead, they started with a wishing price of $4.5M and after 6 months with no takers decide to drop it to $4.195M

Unfortunately, up until a few months ago, the “must sells” had double digit offers in Irvine and other nice areas of Orange County. It still makes little sense to me why the demand coupled with really low interest rates and relatively low supply did not incentivize the banks to dump even more product. More often than not there was 1/2 dozen well qualified buyers lined up to purchase homes that were priced right (relative to the market) and showed well. I really don’t understand what the banks think they are waiting for?

More recently though demand has decreased, I believe, that even if the bank don’t open the flood gates soon, it is possible, if enough supply that can transact comes to the market and demand is weak that these could put enough downward pressure on the market to create signifigatn price decreases that will catch their attention. I have to defer to IR regarding his opinion on what lenders will do besides cry for a bailout if this happens prior to economic recovery.

However, even with the increased supply we are seeing the key is that a low percentage of the product can transact as a result of all of the short sales and the behavior we are seeing from the banks that IR outlined. As a result supply has to be coupled with the ability to transact, which right now is only a limited number of properties.

Can anyone comment on the idea that the tax “amnesty” for those that were foreclosed or short saled will expire in Jan 2011? I heard a story from someone that quit paying on a +$2mm home (now worth $700k) and has tried to quit claim the deed back to the bank for last 2 years. Bank has not responded or foreclosed and now the guy thinks bank is waiting until Jan. to foreclose so he gets screwed on the tax bill? He thinks he will be responsible for the $1.3 debt foregivness. Are banks that smart?

It doesn’t matter when the banksters foreclose, it matters when the owner defaulted payment.

I plan to default in 2011, specifically to take advantage of the Mortgage Debt Forgiveness Act that will expire in 2012.

The housing market will not recover in So Cal anytime soon. Seeing that I plan on retiring in 10 years, I would rather leave the $2000 a month in mortgage payments, rent for $1200, and INVEST (aka mattress fund) the other $800 and use cash. I will not purchase another home as there is no need because both my boys will be 18+.

I’m all CASH now. I’ve learned my lesson. I’ve also learned the LAW isn’t about right and wrong, and I govern my activities appropriately.

From responsible citizen, to “F-U” local, state, and federal governments. Throw in the banksters as well, I only use a credit union and don’t support usury any longer. Live free or die.

This is why i quit paying citimortgage.I should have forty thousand in my safe and walk tax free. Screw this I plan on retiring in three years.By the way screw discover and amex.And I was an honest taxpayer.But now its too late and im too old to start over.All it took was my wife getting laid off next month.

Either they will mark it way down to sell it, or this may be REO until 2018 when their asking price is market.

I’m scratching my chin and squinting here. I don’t think this is a realistic bounce-back for most cities, unless you’re quoting a nominal price in view of inflation – in which case the bank has lost, anyway – or betting on high-end Irvine property bouncing back sooner than most.

Either inflation or a higher floor for the high end in Irvine seems reasonable: together, I guess these two causes could combine to make it happen.

Count me as a skeptic for 2018 in most places, even for the high end. A drop from $4.5M down to $2.5M, followed by a re-ascent to $3.3M – in real terms – sounds about right.

It feels like we are awaiting a big leg down. In my neighborhood; part of Carmichael, CA, there has been no inventory at all, until this summer. Now there is a mix of organic sales, forclosures and flips with some intersting narratives. A decent, REO Condo, 2 bedroom, walking distance from restaurants and stores closed for what was it’s original (new) price from 1992. Near the river there were 9 homes, 2 having been withdrawn, one 1.3 Mil flip (.3 mill over the May purchase) and 6 remaining each with recent $100,000 reductions and no action. I don’t imagine that any except one will trasact this year. The price point that transacts is about $550,000. but as time go by, that represents a nicer house each few months. Pretty much everyone in my neighborhood is pricing in about 8% annual return in their ask. At most the lowest end house (no mortage) has the best shot along with the one-in-a thousand chance that the riverfront home will net a cash buyer. The increase in prices in my neck of the woods is strictly due to the mix of homes, as the floor was in two years ago for the cash-flow rentals. As a refernce point, $550,000 is 6x income. I wish them luck.

I was looking at the South Natomas neighborhood about a year and a half ago. This neighborhood divides along the bike trail and open space that runs N/S with the power lines a few blocks east of Truxel Rd. West of the bike trail is a decent neighborhood with decent, lower-middle-class homes and condos within quick commuting distance of the river and downtown Sac. East of that trail is a slum. Short story: ignore the part east of the bike trail towards Northgate Blvd.

So, as for the western half along either side of Truxel…

I was seeing plenty of sub-$100K SFR’s in the western portion in Spring 2009, but they all evaporated when the tax credit kicked in. Now that the credit has expired, I am seeing $100K SFR’s pop up on my Redfin automated search again. They are just trickling in so far, but I would expect the rate to pick up if we are in for another leg down.